Over the past two years, the federal
government and the Federal Reserve have dispersed trillions of public
dollars, run up enormous deficits, and kept interest rates at zero. In
just about any economic textbook, this combination of policies would
be described as the perfect recipe for inflation. Yet, with the
exception of the usual increases in health care and education, prices
by and large are not rising. Many have concluded that our economic
leadership has simply outsmarted the textbooks.
The benign CPI figures are serving as a
rallying point behind which the financial talking-heads are forming a
parade of optimism. The low CPI is their 'proof' that inflation is not
a pressing concern. This view is two dimensional.
Inflation is classically described simply as
an increase in the money supply. Although these changes will impact
price levels, it doesn't necessarily follow that prices will rise when
inflation is high. Instead, inflation may merely result in stable
prices at a time when prices would otherwise be falling.
In the popular mentality, however, inflation
is simply defined as prices rising. After decades of steadily rising
prices, people seem to have forgotten that prices sometimes fall. In
light of the bursting of a number of record-breaking, government-fueled
asset bubbles, prices should be declining across the board (as they
did in the Great Depression). The fact that prices are stable, or have
even rallied in some sectors, indicates that inflation is already
spreading across the economy.
After falling to just 6,547 in the months
after the crash, the Dow has rallied past the 10,000 mark. This should
strike even novice investors as unjustified. Jobs are still being
lost, a massive healthcare entitlement and carbon tax are winding
through Congress, and no one with at least one foot in the real world
has a palpable sense of imminent recovery. Corporate earnings have
fallen far behind the rally in shares prices, stretching valuation
multiples to pre-crash levels.
While not quite as frothy, home prices are
now moving up for all the wrong reasons. The seminal Case-Shiller
Index of home prices is now up for the fourth month in a row. The
index's designer, Professor Robert Shiller, has stated recently that
the current upward trajectory is unsustainable. In fact, the levels
are still above the 50 and 100 year trend lines.
In the worst economic climate since the
Great Depression, and after the largest housing bust on memory,
single-family home prices should be falling well below the trend
lines. But with a doubling of the monetary base and special interest
programs like the homebuyers' tax credit, home prices have stabilized
and even increased in some markets. That's the work of inflation.
With GDP growth now returning to positive
territory, many inflation hawks ask why inflation has yet to truly
manifest. The explanation can be found in the difference between
monetary base and money supply.
The latest $1.9 trillion injection of
government money was composed of some $900 billion of stimulus, of
which only about 20 percent has been distributed. However, in its
attempts to stabilize the financial system, the government has already
spent some $1 trillion of TARP-type funds.
The TARP money, financed by an increase in
the monetary base, has been provided to the banks at zero cost. And
for the first time ever, the Fed is paying interest on bank reserves.
Therefore, the banks can loan money to the Fed and to the government,
via Treasury securities, at an interest rate spread of some 3 to 4
percent without risk. Given these incentives, it makes no sense to
loan to anybody else. So, despite a massive increase in the monetary
base, credit remains tight and price levels flat.
However, if the Fed stops paying interest on
bank reserves or otherwise 'persuades' the banks to lend, the $1
trillion will be leveraged up by the banks and spewed out into the
economy. Fractional reserve banking will transform a $1 trillion
monetary base injection into a $9 trillion increase in money supply.
When that happens, prices for everything will go through the roof.
So for now, inflation is like a ninja
stalking our economy. It's lurking in the shadows but can't easily be
seen. But once its strikes, it will be fast and deadly.
For a
more in-depth analysis of our financial problems and the inherent
dangers they pose for the U.S. economy and U.S. dollar, read Peter
Schiff's 2007 bestseller "Crash Proof: How to Profit from
the Coming Economic Collapse” and his newest release
"The Little Book of Bull Moves in Bear Markets."
Click here to learn more.
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